Question

Minority shareholders (often NCI shareholders) are owners of a firm but they often have little influence on corporate decisions. However, one mechanism through which minority shareholders may use to protect their interest is litigation. That is, shareholders can sue the firm, managment team or large shareholders if their interests are jeopardised by the decisions or behaviour of the latters. However, excessive litigation has been raised a concern that it may distract management team and induce overly-conservative decisions. Explain which of the above arguments you are more in agreement with.

Answer 1

A shareholder, also referred to as a stockholder, is a person, company, or institution that owns at least one share of a company’s stock, which is known as equity. Because shareholders are essentially owners in a company, they reap the benefits of a business’ success. These rewards come in the form of increased stock valuations, or as financial profits distributed as dividends. Conversely, when a company loses money, the share price invariably drops, which can cause shareholders to lose money, or suffer declines in their portfolios’ values.

A single shareholder who owns and controls more than 50% of a company's outstanding shares is known as a majority shareholder, while those who hold less than 50% of a company’s stock are classified as minority shareholders.

In many cases, majority shareholders are company founders. In older companies, majority shareholders are frequently descendants of a company founders. In either case, by controlling more than half of a company’s voting interest, majority shareholders wield considerable power to influence key operational decisions, including the replacement of board members, and C-level executives like chief executive officers (CEOs) and other senior personnel. For this reason, companies often attempt to avoid having majority shareholders amongst their ranks. Furthermore, unlike the owners of sole proprietorships or partnerships, corporate shareholders are not personally liable for the company's debts and other financial obligations. Therefore, if a company becomes insolvent, its creditors cannot target a shareholder’s personal assets.

Shareholder Rights

According to a corporation's charter and bylaws, shareholders traditionally enjoy the following rights:

• The right to inspect the company's books and records
• To power to sue the corporation for misdeeds of its directors and/or officers
• The right to vote on key corporate matters, such as naming board directors and deciding whether or not to greenlight potential mergers
• The entitlement to receive dividends
• The right to attend annual meetings, either in person or via conference calls
• The right to vote on key matters by proxy, either through mail-in ballots, or online voting platforms, if they’re unable to attend voting meetings in person
• The right to claim a proportionate allocation of proceeds if a company liquidates its assets

Common vs. Preferred Shareholders

Many companies issue two types of stock: common and preferred. The vast majority of shareholders are common stockholders, primarily because common stock is cheaper and more plentiful than preferred stock. While common stockholders enjoy voting rights, preferred stockholders generally have no voting rights, due to their preferred status, which affords them first crack at dividends, before common stockholder are paid. Furthermore, the dividends paid to preferred stockholders are generally larger than those paid to common stockholders. (For related reading, see "What Rights Do All Common Shareholders Have?")

Boards exist to protect shareholders based on the fiduciary duties of care, loyalty, and good faith. If shareholders feel that those duties have not been met by a board or board member, they can take legal action against them.

The “business judgment rule” protects boards and board members from lawsuits for simply making bad choices. As LegalMatch shares, “The business judgment rule requires that courts defer to the board of directors in business matters.

The only exception to the business judgment rule is if shareholders can show that the board of directors engaged in fraud, illegal activities, or were grossly negligent while managing the corporation.”

In other words, boards are afforded the right to make bad business choices as long as there is evidence they were acting in good faith. If there is a belief that the board or a board member has engaged in one of those wrongful practices, there are two options for types of shareholder lawsuits: a direct lawsuit (also called shareholder class action lawsuit) or a derivative lawsuit.

Direct Lawsuits

With direct lawsuits, “A shareholder is appointed to represent a class of plaintiffs, namely, the other shareholders of the corporation who have been harmed by the actions of the defendant director.” In this type of suit, the designated shareholder-plaintiff seeks to prove a degree of personal harm committed by the corporation.

When this occurs, the defendants of the case usually include the board of directors as well as the corporation itself. These types of cases often include hundreds or even thousands of shareholders.

Derivative Lawsuits

Derivative lawsuits are different in that “an individual or shareholder of the corporation would bring suit against the corporation on behalf of the corporation, rather than as an individual person. Derivative suits are usually brought against insiders of the corporations like directors, officers, board members who have been accused or suspected of acts that caused harm against the corporation.”

To put it more simply, a shareholder files a suit on behalf of the corporation against a person or party who has injured said organization. According to Justia, derivative lawsuits have an additional prerequisite.

“State laws and federal procedures almost universally require that the shareholder show that he or she attempted to bring the problem to the attention of company’s directors, but they chose not to pursue the action.”